Circular guide

SUSTAINABLE FINANCE  

Didactic Units 4.4

Wanting to give a definition of sustainable finance, we come up against a rather broad and complex concept, as it can be defined as the alignment of the financial system with the founding principles of the concept of sustainable development. In practice, this alignment, translates into the adoption by the current financial sector, whose main strategy of action is devoted solely to the attainment of profit, towards a holistic approach in which not only the economic but also the social and environmental impacts, generated by financial activities, are taken into account. 

 As repeatedly stated, the achievement of sustainable development goals must be the result of a shared effort, to which corporate entities are also called upon to contribute. It is therefore understandable how, the transition to greater sustainability, necessitates in the meantime a reconversion of the financial sector, as the latter has the delicate task of redirecting capital flows to the companies and activities most involved in the achievement of the goals set forth in Agenda 2030. The redirection of investment decisions toward such activities, the revision of the methods and criteria through which investment choices are made, in addition to generating possible benefits in social and environmental terms, also represents an opportunity for investors who, could thus reduce the negative impacts of their investments, respond to the changing needs and preferences of consumers, while reducing their exposure to the risks posed by the environmental challenges of this century and which, to date represent, one of the main sources of concern for the financial sector.

 

The products, participants and numbers of sustainable finance  

The creation of the first “sustainable” financial products, dates back to the early 2000s following initiatives by the European Investment Bank (EIB) and the World Bank. The products developed in the wake of these initiatives, combine two investment philosophies: the “traditional” approach focused solely on the financial return on investment determined by the riskiness of the investment (which is typically assessed by means of special rating) and the approach of philanthropic donations, which are particularly focused on social and environmental impacts. 

 To date, several sustainable financial products can be found in the financial market that can be traced to two main macro-categories: Sustainable Bonds and Sustainable Loans. The former are defined as bonds issued by financial institutions, organizations, municipalities, and countries, with the aim of financing projects with positive impacts on the environment (Green Bonds) and society (Social Bonds); the latter, on the other hand, are loans granted by banks and linked to sustainability criteria. Taking a look at the numbers in the sector to date, based on estimates released by Bloomberg New Energy Finance in 2019, “sustainable debt” (a definition that encompasses the multiple financial instruments linked to sustainability criteria), would amount to $465 billion globally, registering a year-on-year increase of 78 percent. Primary role is played by Green Bonds, which account for more than half of the market for sustainable products (with a value of issues in the reported year of $271 billion). In second place follow so-called sustainability-linked loans, which reaching a value of $122 billion, registering a 168 percent increase in 2019 alone over the previous year’s performance. 

 The sustainable financial market, in which the previously described products are traded, bears countless similarities to the “traditional” one, both in terms of operation and by virtue of the players involved, among whom one can find:

Capital seekers (capital seekers) who can be divided into issuers and borrowers according to the financial instrument (Bond or Loan) employed to raise funds; 

Investors i.e., those interested in purchasing the financial products or lenders, among whom can be found individuals, public or private banks, governments; 

Regulators and policy makers, who set the rules to ensure the proper functioning of the financial market and who, with a view to the transition to a sustainable financial market, are responsible for determining how to incorporate sustainability issues into financial markets through the development of dedicated policies.

External auditors, the latter are the individuals whose job it is to support investors in making investment choices, ensuring the credibility of financial products in terms of sustainability and assessing whether, those products, are aligned with industry standards and existing regulations. 

Despite the encouraging numbers in the sector, the transactions that take place in these markets still represent a small percentage compared to those recorded globally in traditional markets. This situation is primarily attributable to the fact that, in the current market, investment logics focused primarily on the short term still prevail, thus aiming for a return on investment in the shortest possible time. This condition is compounded by the still existing development of policies, regulations and guidelines, which would allow for a common framework capable of determining which activities and investments can truly be considered sustainable.

The EU taxonomy according to Regulation 2020/852 

On January 14, 2020, the European Commission, as is now well known, unveiled the investment plan of the European Green Deal and the Mechanism for a Just Transition, a tool to be used for the radical transformation of the European economy. Specifically, the investment plan is to be used to achieve Europe’s ambitious environmental goals and, in particular, the achievement of climate neutrality by mid-century. To understand the level of the challenge that the European Union has set for itself, suffice it to say that the latter goal alone (according to the Commission’s own estimates) will require the mobilization of more than 260 billion euros per year, just to hit the intermediate targets set for 2030. 

 Within this framework, the mobilization of public and private capital, will have to be directed toward activities that actually contribute to the achievement of the aforementioned targets. As previously described, however, sustainable finance, still manifests some chronic weaknesses such as the lack of common guidelines to, first, identify activities that tangibly contribute on the sustainability front and, second, to direct capital flows to such operations. 

 With EU Regulation 2020/852 of June 18, 2020, the European Parliament and Council, intervened on the subject by establishing at the EU level a framework that allows the identification, based on specific criteria, of economic activities that can be considered sustainable, also allowing the degree of sustainability of an investment to be determined. Under the regulation the recipients, are represented first and foremost by the world of sustainable finance among which are those offering financial products in the European Union, as they will be required to declare for each product, the extent to which the underlying investments are aligned with the criteria set out in the taxonomy; secondly, governments will also be affected by the new regulatory framework that is emerging since, in the future, this instrument will be used as the basis for the allocation of European incentives; and finally, companies, which are subject to the directive concerning the reporting of non-financial information, will be required to provide information about their activities with reference to the EU taxonomy. 

 Heart of the regulation, as briefly mentioned above, lies in the criteria of eco-sustainability of economic activities. Specifically under Article 3 an activity can be defined as “sustainable” if:  

  • It contributes substantially to the achievement of one or more of the environmental objectives set out in Article 9 such as climate change mitigation and adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, prevention and reduction of pollution, and protection and restoration of ecosystem biodiversity; 
  • Does not significantly harm any of the above objectives, considering the life cycle of the products and services provided by the organization; 
  • It is carried out in compliance with the minimum social guarantees set forth in Article 18 of the aforementioned regulation.

The full operationalization of the taxonomy will be ensured by means of appropriate delegated acts, which will be published and adopted by the Commission: these will contain the technical criteria to be used for the selection of activities to be considered sustainable, based on the principles set out in the EU Regulation. For the criteria related to climate change mitigation and adaptation, they are scheduled to be published as early as the end of December this year. The Commission in the development of the technical criteria will be supported by the Platform on Sustainable Finance, a body composed of experts from academia, civil society and the private sector, which will also perform the task of support in the further implementation phase of the EU taxonomy.

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